Thursday, August 11, 2011

According to an article by WSJ this morning, Kodak's still struggling hard to turn the company around. Mr.Perez and his team have been around long enough to assess the core issues. The addressable markets are all brutally competitive mature markets with surplus capacity following major waves of consolidation from manufacturing to distribution.

The brand name is still highly valuable particularly for non-US manufacturers and consummers. The macro economic headwinds will make Perez's job ten time more difficult as printing is one of the first categories to be downsized in recession. The biggest hurdle I see is the insular, relaxed, homegenous, small-town culture of Rochester that has been ingrained in the company's own culture. This is precisely one of the reasons why Xerox moved its headquarters to Connecticut a while back. Top leadership must have created a much-needed sense of urgency to get its act together.

I believe the company is far more valuable than what its market cap of $476 million currently seems to suggest. Its deep imaging portfolio alone could incubate a dozen Apples and Ciscos. There are many strategic buyers such as Samsung, LG, Konica Minolta, Kyocera Minolta or even Lexmark who would a significant premium for its brand, IP portfolio and imaging & printing businesses.

Instead, Kodal should be focusing on developping a services-led outsourcing business with strategic emphasis on developping markets such as Brazil, Turkey, Indonesia, Russia, Middle East and Africa under a still respected brand name in the business world. Rather than sinking cash into low-end inkjet business (a business that even Xerox abandoned many years ago with far better market dynamics, cash flow and balance sheet), they ought to be looking at medium size acqusitions in the US and around the world. For example, there are many medium size commercial printers in the US that would give Kodak a customer base to churn with own technology as well as entrenched enterprise customer relaitonships.

Trying to do both commercial printing for Graphic Arts customers and consummer and SOHO inkjet printing is a loosing battle given their cash crunch. Without any doubt, they ought to pull the plug on low end inkjet printing busines, perhaps divesting it to Lexmark and exclusively focus on high-end digital printing services aimed at enterprise clients. There is absolutely NO WAY they can afford to successfully fund and grow all three businesses at the same time given current cash generation capacity and market conditions unless they can pull in at least $2-3 billion from selling of IP portoflio.

Wall Street Journal Article:

ROCHESTER, N.Y—After three decades of serial reorganizations, Eastman Kodak Co. is
struggling to stay in the picture.

The 131-year-old company lost much of its film business to foreign
competitors, then mishandled the transition to digital cameras. Now it is
quickly burning through its cash as it remakes itself into a company that sells
printers and ink.

On July 26, Kodak reported its fifth consecutive quarter of losses. The
company's junk-rated debt coming due in two years has moved below 80 cents on
the dollar, signaling the market sees a risk of default. The company's already
battered stock has taken an especially tough pounding in recent days, falling
10% Wednesday to $1.77. Prior to this week, Kodak hadn't closed below $2 since
the 1950s, according to the Center for Research in Security Prices at the
University of Chicago.

Kodak had been raising money by suing companies for its portfolio of patents,
including its image-preview patent. But the flow of settlements dried up this
year, prompting Kodak last month to seek offers on some the patents themselves,
a person familiar with the matter said.

In a sign of how far Kodak has fallen, analysts believe the patent portfolio
is worth more than the company's stock-market value, which has fallen below $500
million.

After the company got a call from a banker late last month describing a
private-equity firm's interest in buying a large stake in the company, Chief
Executive Antonio Perez quickly assembled the board for a weekend conference
call to approve a measure that would deter a hostile takeover, a person familiar
with the matter said. Kodak announced a poison pill Aug. 1 that allows
shareholders to buy stock at a discount if an outside investor acquires a big
stake.

Some former executives say the company probably should have broken itself up
and sold off the parts. Mr. Perez rejects that notion, and it would be
complicated by the company's pension obligations. The board may be more flexible
than its CEO, however. Rick Braddock, Kodak's presiding independent director,
said a breakup doesn't make sense given the company's commitment to a
turnaround. But he added, "I am not going to rule anything out."

Mr. Perez said he remains confident in the company's transition plan. He said
the company will end the year with at least $1.6 billion in cash, up from $957
million now, because he expects intellectual property revenue, asset
disposals—potentially including the patents—and sales to pick up in the second
half.

"You can argue with the degree with which this plan is going to work," the
chief executive said in an interview at the company's Rochester headquarters in
its "Experience Kodak" room, which is filled with Kodak's new printers and
digital cameras, as well as artifacts of the company's glory days. "It's not
that it's not going to work."

Mark Ovaska for The Wall Street
Journal

Kodak CEO Antonio Perez has fought against breaking up
Kodak, even as the company has struggled.

Mr. Perez said the company's heavy cash burn this year reflects the timing of
pension-plan contributions and intellectual-property settlements, not an
underlying problem with the business. Kodak's printers are rapidly gaining
market share, and the business will be highly profitable once a base of users is
established and Kodak can start cashing in on ink sales, he said.

Separately, Kodak got a break earlier this month when a judge who had
initially ruled against the company in a patent suit against Apple Inc. and
BlackBerry maker Research In Motion Ltd. resigned before completing a second
review of the case. Kodak alleges that the camera functions in Apple and RIM
mobile phones violate its image-previewing patent. The case will now be assigned
to a different judge. Mr. Perez has said the suit could bring in $1 billion.
Apple and RIM declined to comment.

Wall Street remains concerned about the company's performance. "It was a
disappointing quarter in cash-flow burn, topline growth and overall growth,"
said Chris Whitmore, an analyst with Deutsche Bank. "They're selling the family
silver to keep the lights on."Mr. Perez, 65 years old, is the fifth Kodak chief in about three decades to
be charged with stopping the company's slide. Their approaches haven't lacked
for creativity. Over the decades, the film giant tried diversifying into
pharmaceuticals, bathroom cleaners and medical-testing devices. None did the
trick.

A Hewlett-Packard Co.
veteran, Mr. Perez picked printers. The plan puts him in competition with giants
like H-P, Canon Inc. and Seiko Epson
Corp., which together control nearly three-quarters of the market, according to
technology data firm IDC.

Kodak began selling printers to consumers in 2007. Its strategy was to turn
the industry's prevailing approach on its head by offering a more expensive
printer and cheaper ink. At its core was a bet that nanotechnology used in
filmmaking would enable Kodak's scientists to produce an ink that wouldn't clog
printer heads, which typically have to be replaced at each refill, adding to the
cost.

By 2010, the company held 3% of the all-in-one inkjet printer market
world-wide, according to IDC, up from 1% in 2008. Kodak's strategy is to
subsidize the cost of the printers until its installed base is big enough to
generate a lot of ink sales. Still, because its ink refills are cheaper, Kodak
is able to sell its printers at a higher price than competitors.

While acknowledging that Mr. Perez inherited a difficult business challenge,
people inside the company say missteps have slowed Kodak's transformation. Early
versions of Kodak's printers were plagued by problems, like printhead failures
that required Kodak to cover the cost of replacements, said a person familiar
with the matter. By the time the company sorted out the complications, the
recession had set in.

Kodak's board of directors maintains its support for Mr. Perez and his
strategy. In September 2009, it talked him out of retiring and renewed his
contract through 2013. Kodak's shift to a new strategy "is really one of the
hardest business transitions I have ever seen,'' said Mr. Braddock, the
presiding director.

For generations, Kodak reaped profits from one high-margin product: film.
With the credo "You press the button, we do the rest," Kodak's affordable film
and cameras transformed photography from a highly skilled pursuit to a pastime
of the everyman.

By the 1980s, troubles were mounting as foreign film competitors took share
from Kodak and digital technologies emerged. Kodak says it invented the world's
first digital camera in 1975 and spent hundreds of millions of dollars
developing digital technology. Yet the fear of cannibalizing its film sales
paralyzed the company when it came time to go to market.Kodak's struggles have taken a toll on Rochester. In 2004, Kodak employed
16,300 workers in the city. As of 2010, that number was just 7,100. Over the
same period, the company's global work force has shrunk to 18,800 from
54,800.

Kodak's insular corporate culture, encouraged by the town's isolation, bears
much of the blame for Kodak's failure to adapt, former employees say. A retired
board member says an outside consultant hired by management in the early 1990s
prepared a report titled "The Poisoned Inheritance" criticizing the company's
inwardly focused culture. Management's reaction? "Ho hum," he said, adding that
few independent directors even saw the report.

Mr. Perez joined Kodak in 2003 as president and chief operating officer
following a 25-year-career at H-P, where he headed the company's inkjet printer
business. At H-P, he led an effort to acquire Kodak, during which he says he
became fascinated by the company's intellectual property. Leaving H-P after Carly
Fiorina beat him out for the top post, Mr. Perez took his printer know-how
to Kodak.

When he was tapped by the board to become chief executive in 2005, Mr. Perez
was given three goals: Shrink the film business, create a new digital company
and manage its pension and health-care costs for retirees. Each is enormously
expensive. The company says restructuring film alone cost $3.4 billion over four
years. The company's operations don't generate enough cash to cover all the
expenses.

From early on, Kodak began amassing patents related to film and coating
technology. It's registered more than 11,000 patents, with many of the new ones
focused on digital technology like its image-previewing patent. To fund the
massive investment his digital strategy required, Mr. Perez started litigating
and licensing Kodak's digital-imaging patents, a strategy that brought in $1.9
billion from 2008 to 2010.

The drought in income from patents suits this year prompted the company to
look more seriously at selling patents, one board member said. The plan was
approved at a meeting in Connecticut in mid-July, this director said. Kodak is
also looking to sell off or lease 2.5 million square feet at what used to be its
major manufacturing center in Rochester, Kodak Park.

Mr. Perez says he spent his first months at Kodak wandering its sites and
factories, assembling an internal group of "rebels" to get to know the
operations. During a weekly meeting with his "R-team," he learned of a
continuous inkjet project one of the labs was working on. Because of the
company's film background, Kodak had the capability to make pigment-based ink
that wouldn't clog the nozzles of printing heads.

Mr. Perez said he presented a number of digital businesses to the board. They
included document scanners, high-tech display panels and new sensor technology.
"I started with 11, and I told the board that at least 30% of them were the
wrong ones, but I didn't know which ones," Mr. Perez said.

The board approved all 11 digital businesses, but Mr. Perez and management
later stopped pursuing two of them. The company's fate now rests primarily on
printing. Kodak originally forecast that its consumer printers would break even
in 2010, but later pushed the time frame to 2011.

A former executive who recently left the division says Kodak overestimated
its ability to penetrate the printer market and there are doubts internally
about whether the 2011 target can be met. Mounting competition has pushed down
printer prices, raising another hurdle to profitability.

Revenue from sales of consumer inkjet printers and ink grew by 48% in the
second quarter. "We are taking share from everyone," said Mr. Braddock, the
director. Mr. Perez said the business could become instantly profitable by
eliminating its subsidies for consumers who buy its printers, but that doing so
would hurt efforts to build a base for ink sales.

Kodak's commercial printing business, geared toward publishers and marketers,
has even further to go. The company aims to sell room-size machines that can
print thousands of pages a minute, each of them with different content. So far,
it has only a few dozen customers and is building the complicated machines by
hand.

In the second quarter, losses in the commercial group swelled to $45 million
from $17 million a year earlier, due largely to unanticipated costs of adapting
the complicated technology to customers' environments.

Mr. Perez, who has surrounded himself with former H-P executives, is pressing
ahead with printing. To keep up employees' morale, he draws on his experience as
a former runner, saying when he used to run 10,000-meter races, the last two
kilometers were always the hardest.

"At the same time, this is the time you can lose the race," he said. "So keep
running."

Posted by
Hakan Akbas

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HAKAN AKBAS is the Founder and Managing Partner of Global Dealings LLC a boutique advisory firm committed to providing best management and private equity advisory in Turkey, Middle East and Africa. Hakan has more than 20 years of progressively responsible experience directing as many as 5,000 employees domestically and in emerging markets with revenues in excess of $2.5 billion. Hakan has led these private and public companies through start-up, restructuring, turnaround and growth modes.

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